Texas Supreme Court Issues Opinion with Implications for Power Purchase Agreements

by King & Spalding
Contact

The Texas Supreme Court recently issued an opinion with implications for negotiating terms in power purchase agreements in the renewable energy market. In FPL Energy LLC, et al. v. TXU Portfolio Management Co., LP, the Court examined the nature of electricity as a good, finding it should be treated no differently than any other commodity when interpreting contracts. 2014 WL 1133329 (Mar. 21, 2014). The Court further considered and rejected as unenforceable a liquidated damages provision because it had no rational relationship to the actual damages, overturning a $29 million damages assessment.

Background

In 1999, the Texas Legislature sought to increase the use of renewable energy sources in Texas. The Legislature directed the Texas Public Utility Commission ("PUC") to establish minimum requirements for renewable energy production and to develop a renewable energy credit ("REC") marketplace. Electric providers who are unable to meet requirements may purchase RECs in lieu of electricity generation through renewable sources.

In FPL Energy, TXU Electric ("TXU") contracted to purchase electricity and RECs from three wind farms owned by FPL. FPL failed to deliver enough electricity and RECs to TXU to satisfy its contract. After TXU sued FPL, FPL argued it could not meet its contractual requirements because the power grid was congested, or in other words, the grid lacked capacity to transmit all of the energy in a certain area. When the grid is congested, a state agency issues curtailment orders to facilities to cease production. FPL received such orders and produced less energy. FPL claimed that TXU bore the responsibility for the limited energy production because TXU was responsible for ensuring transmission capacity for all of the energy that FPL produced.

The Court's analysis focused on two issues: (1) whether TXU owed FPL a duty to provide sufficient transmission capacity for FPL's energy production; and (2) whether a liquidated damages provision in the parties' contract was enforceable.

Electricity Nothing Special—No Duty to Ensure Capacity

The Court found that the parties' contract placed the risk of a congested grid on FPL. In interpreting the contract, the Court found that the location of the electricity was a driving factor in the contract's risk structure. Specifically, the Court explained that TXU's transmission obligations arose only when FPL's electricity actually reached a certain delivery point. But electricity generation, transmission, and distribution occur almost simultaneously, making it difficult to pinpoint the electricity's physical location. The Court found that even if electricity moves too fast for the parties to truly physically pinpoint its location, the parties could "conceptualize" the location to negotiate contracts and to assign risk. Accordingly, the "unique nature of electricity" did not impact the Court's contractual analysis.

REC a Distinct Commodity

In interpreting the liquidated damages provision in the FPL-TXU contract, the Court found that it applied only to RECs because it did not mention "electricity." After examining the entire contract, the Court concluded that the omission of electricity from the liquidated damages provision was deliberate. Limiting the liquidated damages provision to RECs advanced stability in the renewable marketplace. RECs and electricity are unbundled—electric providers may generate either renewable energy or purchase RECs on the open market. In short, the Court recognized that RECs and electricity are two separate commodities that may be contracted for separately (though in this case they were not). Because the plain language of the FPL-TXU contract was clear, the Court refused to ascribe additional meaning to a REC, and noted that to do so would create uncertainty regarding the desirability of electricity/REC investments, impact the negotiation of future contracts, and impede regulatory compliance.

Enforceability of Liquidated Damages

A shortfall in RECs triggered liquidated damages of the lesser between $50 per deficient MWh or two times the market value of each deficient REC if the PUC had made a determination of market value. At the time of FPL's failure to deliver, the market value of a REC ranged from $4 to $14, but the PUC had not made a determination of the same.

A liquidated damages provision must be a reasonable forecast of just damages. A liquidated damages provision may be unenforceable if the actual damages incurred are less than the amount contracted for. Importantly, the reasonableness of an actual damages forecast should be analyzed as of the time of contracting.

At the time of contracting in FPL Energy, there was no REC marketplace, and thus no market value. The $50 per MWh option represented the PUC's actual penalty for failing to meet renewable requirements. At the time of calculating liquidated damages, the PUC had not made a determination of market value, and so the $50 per MWh was initially used in the liquidated damages calculation.

The Court, however, found that applying the liquid damages provision to the facts of the case rendered it unenforceable as a penalty. The Court explained that $50 per MWh did not tie the damages to market value and that the "fortuity" of the PUC making a market value determination controlled the damages, regardless of the actual market value of a REC. The Court explained it could not enforce provisions where there is an "unbridgeable discrepancy between the liquidated damages provisions as written and the unfortunate application in reality," and further, that the provision was unreasonable because it had no "rational relationship to actual damages."

This analysis indicates that efforts to forecast a reasonable actual damages amount at the time of contracting may be trumped by whether the liquidated damages provision ties to actual damages at the time it is applied. Indeed, when the FPL-TXU contract was negotiated, the provision was arguably reasonable—there was not yet a marketplace for RECs and the $50 was pulled from the applicable regulatory scheme. This provision only became unreasonable after contracting when the market value of a REC resulted in a disparity between actual damages and liquidated damages.

Elizabeth R. Taber
Houston
+1 713 276 7304

etaber@kslaw.com
View Profile »

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© King & Spalding | Attorney Advertising

Written by:

King & Spalding
Contact
more
less

King & Spalding on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.